SOVEREIGN ratings are aimed at assessing the creditworthiness of a country as an issuer of debt, i.e., as borrower; or assessing the default probability of individual government bonds. These ratings are assigned by credit-rating agencies, are constantly monitored and updated, and serve as investment standards for international fund managers and other investors, including multilateral institutions and governments themselves.
Since sovereign ratings are assigned to most countries, especially by the so-called Big Three global rating agencies—Standard & Poor’s, Moody’s and Fitch—they are taken as comparative measures of general performance, based as they are on economic and political conditions and criteria.
Sovereign ratings matter, not just because a good rating reduces the cost of borrowing, but because they rank a country against other countries in terms of a composite of common general criteria—and a country’s rating has reputational value in attracting foreign investments. In fact, for so long, the Philippines has been obsessed with trying to obtain an investment-grade rating, which it eventually did recently, in 2013.
It had been the complaint of the Philippines, and other Asian countries, that the credit ratings of the Big Three Western rating agencies have been biased against the emerging countries, compared to their ratings of European countries. So some Asian government authorities have proposed to organize an Asian regional credit-rating agency co-owned by private institutions from different Asian countries. Other quarters propose an entire overhaul of existing sovereign ratings methodology.
In other words, there is a growing sense that the present methodology of sovereign ratings—on which depend in a big way the direction and magnitude of cross-border investments—might no longer be adequate to serve the current requirements for the evaluation of creditworthiness. This was the general subject matter of two recent international forums: The World Credit Rating Forum in Beijing on June 29, sponsored by Dagog Global Ratings and Universal Credit Rating Group (UCRG); and the Sovereign Ratings Dialogue in Tokyo on July 10 cosponsored by the Association of Credit Rating Agencies in Asia (ACRAA), ADB Institute and Japan Credit Rating Agency.
In these forums, the mood was for reform. But perhaps, the initial question should be raised: What’s wrong with the existing rating methodologies? Let’s look at a comparison of the general “evaluation points” of three rating agencies, applied to sovereign ratings.
Japan Credit Rating (JCR) evaluates: (1) Fiscal position; (2) External position;
(3) Economic foundation; (4) Social and political foundation; (5) Financial system; (6) Economic policy; and (7) International relations.
Moody’s categorizes its sovereign-rating methodology into four major rating factors: (1) Economic strength; (2) Institutional strength; (3) Fiscal strength and (4) Susceptibility to event risk.
Standard & Poor’s enumerates five general evaluation factors: (1) Institutional effectiveness; (2) Economic assessment; (3) External assessment; (4) Fiscal assessment; and (5)
Monetary assessment.
The broad evaluation criteria are similar, but each rating agency has its own method of defining the details of the broad criteria and translating them into rating matrices which create differentiations. Each rating agency follows its own formula of applying its rating criteria. It can get complicated.
Refined as present sovereign-rating methodologies are, still rating agencies themselves recognize the need to enhance their capabilities and approaches to sovereign ratings, realizing how these are used to benchmark investment decisions and influence investment flows. They are constantly reviewing and updating their methodologies, and are duly published. This is an important point to note.
As observed by ACRAA Chairman Faheem Ahmad, credit-rating agencies have been accused of not only being too slow to change ratings to be of timely use for investors, but also of downgrading more than the worsening fundamentals justified, as shown during the 1997 Asian crisis.
But again, what this column reassures is that credit-rating agencies are addressing the challenges for improving sovereign ratings, to make them more useful and relevant. Whatever the methodology, sovereign ratings are here to stay.